May not always bond

If you have often felt that the Rs 1 lakh income-tax deduction limit was a constraint on your tax-saving abilities, here's another avenue you can resort to-long-term tax-saving infrastructure bonds. Through these bonds you can claim tax deduction for investment of another Rs 20,000 and save tax up to Rs 6,180 at the highest tax bracket. As the current financial year enters its last quarter and the investment deadline for saving tax (31 March) looms ahead, many infrastructure companies have lined up the launches of their taxsaving bonds.

Infrastructure Development Finance Company (IDFC) and Larsen & Toubro (L&T) have already launched the first series of their tax-free infrastructure bonds and are planning a relaunch, while IFCI has issued two series of its bonds. Other infrastructure companies that will soon follow suit are India Infrastructure Finance Company Limited (IIFCL), Rural Electrification Corporation (REC) and PTC Financial Services.

Taxpayers can claim incometax deduction for investment of up to Rs 20,000 in long-term infrastructure bonds under Section 80CCF of the Income Tax Act. This move was announced in Budget 2010 with the aim of channelising domestic savings into the infrastructure sector. Under this regulation, the government has allowed lending by IFCI, IDFC, Life Insurance Corporation of India (LIC) and non-banking finance companies exclusively to infrastructure sector to raise money through these bonds.

Who can Subscribe to these Bonds?An Indian resident and Hindu undivided families (HUFs) can invest in these bonds. According to Naval Bir Kumar, managing director, IDFC Mutual Fund, any taxpayer who has exhausted the Rs 1-lakh limit under Section 80C should consider investing in these bonds, especially those in the higher tax brackets.

As most of these bonds are highly rated long-term bonds, they are low-risk investment options which suit retired investors. However, they are not completely risk-free due to the risk of default in such bonds and investors should check the rating assigned to these issues. "While putting their money in an infrastructure bond, investors should check its rating. A triple A rated (AAA) bond is a good tax saving-cum-investment option," says Kumar.

The bonds can be issued in both demat and physical form. "Since these bonds are aimed at all taxpayers, it is necessary to offer them in both forms as many taxpayers do not have demat accounts," adds Kumar.

Minimum Investment and Lock-in PeriodThe minimum investment amount for these bonds is Rs 5,000 and in multiples of Rs 5,000 thereafter. The tenure of the bonds is 10 years, with a minimum lock-in period of five years. Companies offer a buyback option to investors after this period. These bonds will be made available on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) for trading after the mandatory lock-in period. After the five-year period, an investor can even take loans against these bonds.

However, as these bonds are new to the investing arena, they don't have an established trading market. This means there is no certainty that an active public market for such bonds will develop in the future.

Expected ReturnsMost infrastructure bonds that have been launched have a coupon (interest rate) between 7.5 per cent and 8.25 per cent. The second series of bonds issued by IFCI, which concluded recently, had a coupon of 8 per cent with a buyback option after five years and 8.25 per cent with no buyback option. IDFC, which is planning to come out with its second tranche of infrastructure bonds this quarter, may also offer the same interest rate (8-8.25 per cent) on its infrastructure bonds.

The reason most companies are offering similar coupons is because there is a cap on the interest rate on the infrastructure bonds paid by the issuer. The rate cannot exceed the yield on government securities of the same maturity period, which is based on the last working day of the month immediately preceding the month when the bond was issued. The tax-adjusted yield on these bonds will differ on the basis of the income tax slab within which one's income falls. The table above (What you will Earn) gives the tax-adjusted returns for different tax slabs.

Should you Invest in them?As infrastructure bonds are an additional tax-saving avenue, you can consider them a good option if, and only if, you have exhausted the Rs 1 lakh limit under Section 80C. This is because many tax-savings instruments, such as ELSS, Ulips and NPS, offer better returns than these bonds.

Vikas Vasal, executive director, KPMG, says that as it is an added option to save tax, investing in such bonds makes sense. However, he feels that the amount of tax one saves through these bonds is too less and the five-year lock-in period makes them less appealing. Investors, especially in the 10 per cent tax category, may take a call on whether it is worth saving tax of Rs 2,000 by locking in Rs 20,000 for 5-10 years.

The maximum taxadjusted return for investors in the 10 per cent tax slab is 10.77 per cent (see table). Investing the same amount in a good equity mutual fund can fetch you 15-20 per cent returns without locking the amount for five years. As there is no long-term capital gains tax on returns earned from equity funds, for investors with higher risk appetite, this option could be a better bet than infrastructure bonds.